Wednesday, October 13, 2010

Toxic tsunami of student debt

David Willets, our current Minister for Universities wrote The Pinch: How the Baby Boomers Took Their Children's Future - And How They Can Give it Back. Read that title again, and ask yourself whether he understands the word ‘duplicity’! Having just put the burden of Higher Education firmly onto the next generation through interest-based loans, he’s not practising what he preaches. Is this, in effect, political short-termism, a ruse to protect baby boomers from tax rises? Or is it a progressive tax that makes the recipients of the benefits of HE pay their fair share? I’m not yet sure, but one topic does worry me – the normalisation of debt.

Is it worth it?

Before embarking on a loan-based degree students should do their homework. A four year degree may result in you leaving with a loan north of £30,000-£40,000. Current orthodoxy says having a degree means you’ll earn £100,000 more in your lifetime, but the gap may be closing and may end up being nil or even a loss. All loans have a risk associated with them and there are several risks that underlie student loans.

Falling earnings differential

The calculated difference in earnings between graduates and others may close, as more students hit the market (currently 45% of all young people are going to university). As this gap closes the rationale for the loan starts to disappear, as does your ability to pay. It is not at all clear that having a degree will always result in more earnings. Unemployment among the young is rising at an alarming rate across Europe. The assumption that you’ll have a job is now under threat, never mind your ability to repay student debts. It won’t be student debt that’s the problem, but social unrest. This really could be the generation that will be worse off than their parents. No one is expected to pay until they are in work, but if unemployment is a problem, so is the paying back of the loans.

Sacrificed earnings

What the orthodox argument doesn’t say is that you’ll be sacrificing three or four years of income while at university. This could be between £45,000 to £100,000 in lost earnings and career advancement. This may prove to be an unrecoverable sum in your lifetime.

Rising interest rates

A student loan is like a second mortgage, and similar in scale. Although interest rates are low at the moment, that is artificial unsustainable, and a feature of quantitative easing. Interest rates will rise, so mortgage payments will rise. Students can expect rising mortgage payments, when they buy a house, and a cumulative debt that could be beyond their ability to pay.

Dropouts

What happens to students who drop out of their courses? Do they still have to repay the loans? If they don’t the cost falls back on the state or loan provider? In the US three quarter of all student loan defaulters are those who dropped out of courses.

Debt collection and bankruptcy

The real issue here is how these loans are collected. They are given out by an arm’s length body, the student loan company but collected by the Inland revenue. This allows them to ‘sell’ the debt to the private sector, as the state effectively securitises the loan. But that doesn’t in itself solve the problem, if we have mass defaults.

Debt collection agencies in the US have been buying up existing student debt, as chasing young adults is seen as easy pickings. It’s sometimes suggested that bankruptcy is the way out, but in the US, this is rarely an option. Student loans are difficult to discharge through bankruptcy. In any case, bankruptcy in this country means severely limiting your ability to get credit and may seriously damage your potential future earnings. Interestingly, if the economy goes into another deep recession, which many think is likely, defaults in student loans are certain. The cost of debt collection is considerable.

Toxic

So, these loans may turn out to be toxic. With towards half a million students entering our universities every year, a huge amount of debt is piling up as they graduate. Those earning less than £15,000 will pay no interest, but the debt remains. The rest will be paying a variable amount of interest. This is a bubble and bubbles have a habit of…….. (fill in the gap).

Caveat

I understand that the above analysis, deals with a University education as a commodity and it’s much more than this.

3 Comments:

Might I add that creating £4.2billion (600,000 x £7000) from thin air each year as 'loans' (debt) - wouldn't this be massively inflationary?

To put it into context, the current mortgage market is £11 billion per year. But as you say - repayment on student loans may not be as guaranteed.

I am sure savvy consumers will work out - especially using online repayment calculators (http://www.thisismoney.co.uk/loan-repayments-calculator) that at some point it becomes economically unviable to go to university and the repayments are too damaging to your liquidity. I worked it out to be about £15k per year.

For info. based on £40K over 25 years at current RPI+2.2% means repaying about £280 per month.

I think you are correct in that they are proposing something that will be a carbon copy of the recent banking crisis, but is likely to be worse.

It is one of those moments you think 'Am I the only one...' - thankfully I am not.